Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial condition and results of operations of
iRobot Corporation should be read in conjunction with the consolidated financial
statements and the related notes thereto included elsewhere in this Quarterly
Report on Form 10-Q and the audited financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in our Annual Report on Form 10-K for the year ended
December 28, 2013, which has been filed with the SEC. This Quarterly Report on
Form 10-Q contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, and are subject to the "safe harbor" created
by those sections. In particular, statements contained in this Quarterly Report
on Form 10-Q, and in the documents incorporated by reference into this Quarterly
Report on Form 10-Q, that are not historical facts, including, but not limited
to statements concerning new product sales, product development and offerings,
Roomba, Scooba, Looj, Braava and Mirra products, PackBot tactical military
robots, the Small Unmanned Ground Vehicle, FirstLook, Kobra, Ava, RP-VITA, our
home robots, defense and security robots and remote presence business units, our
competition, our strategy, our market position, market acceptance of our
products, seasonal factors, revenue recognition, our profits, growth of our
revenues, product life cycle revenue, composition of our revenues, our cost of
revenues, units shipped, average selling prices, funding of our defense and
security robot development programs, operating expenses, selling and marketing
expenses, general and administrative expenses, research and development
expenses, and compensation costs, our projected income tax rate, our credit and
letter of credit facilities, our valuations of investments, valuation and
composition of our stock-based awards, and liquidity, constitute forward-looking
statements and are made under these safe harbor provisions. Some of the
forward-looking statements can be identified by the use of forward-looking terms
such as "believes," "expects," "may," "will," "should," "could," "seek,"
"intends," "plans," "estimates," "anticipates," or other comparable terms.
Forward-looking statements involve inherent risks and uncertainties which could
cause actual results to differ materially from those in the forward-looking
statements, including those risks and uncertainties described in our Annual
Report on Form 10-K for the year ended December 28, 2013, as well as elsewhere
in this Quarterly Report on Form 10-Q. We urge you to consider the risks and
uncertainties discussed in our Annual Report on Form 10-K and in Item 1A
contained herein in evaluating our forward-looking statements. We have no plan
to update our forward-looking statements to reflect events or circumstances
after the date of this Quarterly Report on Form 10-Q. We caution readers not to
place undue reliance upon any such forward-looking statements, which speak only
as of the date made.
Overview
iRobot designs and builds robots that empower people to do more. For over
20 years, we have developed proprietary technology incorporating advanced
concepts in navigation, mobility, manipulation and artificial intelligence to
build industry-leading robots. Our home care robots perform time-consuming
domestic chores, while our defense and security robots perform tasks such as
battlefield reconnaissance and bomb disposal, and multi-purpose tasks for law
enforcement agencies and first responders, as well as certain commercial users.
Our remote presence robots expand the reach of medical care by connecting
physicians with patients from anywhere in the world and also provide autonomous
telepresence capabilities enabling remote workers to more personally collaborate
throughout the workplace. We sell our robots through a variety of distribution
channels, including chain stores and other national retailers, through our
on-line store, through value-added distributors and resellers, and to the U.S.
military and other government agencies worldwide.
As of June 28, 2014, we had 548 full-time employees. We have developed expertise
in the disciplines necessary to build durable, high-performance and
cost-effective robots through the close integration of software, electronics and
hardware. Our core technologies serve as reusable building blocks that we adapt
and expand to develop next generation and new products, reducing the time, cost
and risk of product development. Our significant expertise in robot design and
engineering, combined with our management team's experience in consumer,
military and enterprise markets, positions us to capitalize on the expected
growth in the market for robots.
Although we have successfully launched consumer and defense and security
products, our continued success depends upon our ability to respond to a number
of future challenges. We believe the most significant of these challenges
include increasing competition in the markets for both our consumer and defense
and security products, and our ability to successfully develop and introduce
products and product enhancements into both new and existing markets.
During the three and six month periods ended June 28, 2014, strong growth in our
global markets for home robots products drove increases in our home robots
business unit revenue of 15% and 16%, respectively, as compared to the three and
six month periods ended June 29, 2013. These increases resulted from expanded
distribution of our Roomba 800 series robot, as well as continued growth in
China. Offsetting these increases were decreases in our defense and security
business unit revenue of 59% and 55%, respectively, during the three and six
month periods ended June 28, 2014 compared to the three and six month periods
ended June 29, 2013.

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During the three month period ended June 28, 2014, we recorded a net benefit to
revenue and income before income taxes of $1.2 million and $2.6 million,
respectively, related to adjustments to our product returns reserves, compared
to a net benefit to revenue and income before income taxes of $3.5 million
related to adjustments to our product returns reserves during the three month
period ended June 29, 2013. The adjustments recorded in both periods resulted
from lower product returns experience.
Additionally, we released $2.1 million of valuation allowance related to certain
tax attributes of Evolution Robotics, Inc. during the three month period ended
June 28, 2014, compared to the release of $2.7 million of certain income tax
reserves due to favorable conclusions of the IRS examination of our income tax
returns for the years 2008, 2009 and 2010 during the three month period ended
June 29, 2013.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the dates of the
financial statements and the reported amounts of revenue and expenses during the
reporting periods. On an ongoing basis, we evaluate our estimates and judgments,
in particular those related to revenue recognition (specifically sales returns
and other allowances); valuation allowances; assumptions used in valuing
goodwill and intangible assets; assumptions used in valuing stock-based
compensation instruments; evaluating loss contingencies; and valuation
allowances for deferred tax assets. Actual amounts could differ significantly
from these estimates. Our management bases its estimates and judgments on
historical experience and various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities and the
amounts of revenue and expenses that are not readily apparent from other
sources. Additional information about these critical accounting policies may be
found in the "Management's Discussion and Analysis of Financial Condition and
Results of Operations" section included in our Annual Report on Form 10-K for
the fiscal year ended December 28, 2013.
Overview of Results of Operations
The following table sets forth our results of operations as a percentage of
revenue for the three and six month periods ended June 28, 2014 and June 29,
2013:

Total revenue for the three months ended June 28, 2014 increased to $139.8
million, or 7.2%, compared to $130.4 million for the three months ended June 29,
2013. Revenue increased approximately $17.7 million, or 15.3%, in our home
robots business unit and decreased approximately $7.4 million, or 59.1%, in our
defense and security robots business unit.
The $17.7 million increase in revenue from our home robots business unit for the
three months ended June 28, 2014 was driven by a 14.8% increase in units shipped
and a 1.3% increase in average selling price as compared to the three months
ended June 29, 2013. In the three months ended June 28, 2014, international home
robots revenue increased $14.9 million, or 19.5%, and domestic home robots
revenue increased $2.9 million, or 7.3%, as compared to the three months ended
June 29, 2013. Total home robots shipped in the three months ended June 28, 2014
were 565,000 units compared to 492,000 units in the three months ended June 29,
2013. The increase in sales of our home robots, both domestically and
internationally, resulted primarily from broadened availability of our Roomba
800 series robot. Continued growth in China also contributed to the increase in
international sales of our home robots. These increases were partially offset by
a $1.2 million favorable adjustment recorded to our returns reserve during the
three month period ended June 28, 2014 compared to a $3.5 million favorable
adjustment recorded to our returns reserve during the three month period ended
June 29, 2013.
The $7.4 million decrease in revenue from our defense and security robots
business unit for the three months ended June 28, 2014 was attributable to a
$6.4 million decrease in defense and security product revenue and a $1.0 million
decrease in contract revenue generated under research and development contracts.
In the three months ended June 28, 2014, international defense and security
robots revenue increased to 74% of total defense and security robots revenue,
from 7% of total defense and security robots revenue in the three months ended
June 29, 2013. The $6.4 million decrease in defense and security product revenue
resulted primarily from decreased sales of our FirstLook robots of $6.9 million
and decreased sales of spare parts of $1.1 million, partially offset by
increased sales of our Packbot robots of $2.0 million. The $1.0 million decrease
in contract revenue was primarily due to revenue related to the U.S. Army's
Brigade Combat Team Modernization, or BCTM program, for which efforts were
completed during the three months ended June 29, 2013. Total defense and
security robots shipped in the three months ended June 28, 2014 were 40 units
compared to 424 units in the three months ended June 29, 2013, while average
selling price increased from $20 thousand in the three months ended June 29,
2013 to $80 thousand in the three months ended June 28, 2014. The decrease in
the number of units shipped and the increase in average selling price resulted
from decreased sales of our lower-priced FirstLook robot in the three months
ended June 28, 2014 as compared to the three months ended June 29, 2013.
Total revenue for the six months ended June 28, 2014 increased to $254.0
million, or 7.4%, compared to $236.6 million for the six months ended June 29,
2013. Revenue increased approximately $33.0 million, or 15.9%, in our home
robots business unit and decreased approximately $12.9 million, or 54.6%, in our
defense and security robots business unit.
The $33.0 million increase in revenue from our home robots business unit for the
six months ended June 28, 2014 was driven by a 12.8% increase in units shipped
and a 3.0% increase in average selling price as compared to the six months ended
June 29, 2013. In the six months ended June 28, 2014, international home robots
revenue increased $20.6 million, or 14.9%, and domestic home robots revenue
increased $12.5 million, or 17.7%, as compared to the six months ended June 29,
2013. Total home robots shipped in the six months ended June 28, 2014 were
1,030,000 units compared to 913,000 units in the six months ended June 29, 2013.
The increase in sales of our home robots, both domestically and internationally,
resulted primarily from broadened availability of our Roomba 800 series robot.
Continued growth in China also contributed to the increase in international
sales of our home robots. These increases were partially offset by a $1.7
million favorable adjustment recorded to our returns reserve during the six
month period ended June 28, 2014 compared to a $3.5 million favorable adjustment
recorded to our returns reserve during the six month period ended June 29, 2013.
The $12.9 million decrease in revenue from our defense and security robots
business unit for the six months ended June 28, 2014 was attributable to a $8.8
million decrease in defense and security product revenue and a $4.0 million
decrease in contract revenue generated under research and development contracts.
In the six months ended June 28, 2014, international defense and security robots
revenue increased to 58% of total defense and security robots revenue, from 12%
of total defense and security robots revenue in the six months ended June 29,
2013. The $12.9 million decrease in defense and security product revenue
resulted primarily from decreased sales of our FirstLook robots, as well as
decreased sales of spare parts for our Small Unmanned Ground Vehicle and Packbot
robots. These decreases were partially offset by increased sales of our Packbot
robots. The $4.0 million decrease in contract revenue was primarily due to a
decrease in revenue related to the BCTM program, for which efforts were
completed during the three months ended June 29, 2013. Total defense and
security robots shipped in the six months ended June 28, 2014 were 78 units
compared to 442 units in the six months ended June 29, 2013, while average
selling price increased from $24 thousand in the six months ended June 29, 2013
to $67 thousand in the six months ended June 28, 2014. The decrease in the
number of units shipped and the increase in average selling price resulted from
decreased sales of our lower-priced FirstLook robot in the six months ended
June 28, 2014 as compared to the six months ended June 29, 2013.

Total cost of revenue increased to $77.7 million in the three months ended
June 28, 2014, compared to $68.8 million in the three months ended June 29,
2013. Cost of revenue increased $12.2 million, or 21.7%, in our home robots
business unit, and decreased $3.3 million, or 50.6%, in our defense and security
business unit. The increase in cost of revenue for the three months ended
June 28, 2014 in our home robots business unit is primarily due to the 14.8%
increase in home robots units shipped as compared to the three months ended
June 29, 2013. The decrease in cost of revenue for the three months ended
June 28, 2014 in our defense and security business unit resulted from the 59.1%
decrease in revenue.
Total cost of revenue increased to $140.2 million in the six months ended
June 28, 2014, compared to $128.4 million in the six months ended June 29, 2013.
Cost of revenue increased $17.7 million, or 17.0%, in our home robots business
unit, and decreased $5.6 million, or 45.4%, in our defense and security business
unit. The increase in cost of revenue for the six months ended June 28, 2014 in
our home robots business unit is primarily due to the 12.8% increase in home
robots units shipped as compared to the six months ended June 29, 2013. The
decrease in cost of revenue for the six months ended June 28, 2014 in our
defense and security business unit resulted from the 54.6% decrease in revenue.

Gross margin increased $0.5 million, or 0.8%, to $62.1 million (44.4% of
revenue) in the three months ended June 28, 2014 from $61.6 million (47.3% of
revenue) in the three months ended June 29, 2013. Gross margin as a percentage
of revenue in the home robots and defense and security business units decreased
2.7 percentage points and 10.8 percentage points, respectively. The
2.7 percentage point decrease in the home robots business unit resulted from
incremental warranty reserves of $2.0 million, driven primarily by actual
warranty experience in certain European markets. In addition, increases in
margins for our Roomba robots were offset by a higher mix of lower margin wet
floor care products, as well as increases in other costs of sales during the
three month period ended June 28, 2014 compared to the three month period ended
June 29, 2013. We also recorded a smaller favorable adjustment to our returns
reserve during the three month period ended June 28, 2014 than the favorable
adjustment recorded to our returns reserve during the three month period ended
June 29, 2013. The 10.8 percentage point decrease in the defense and security
business unit is mostly attributable to the unfavorable overhead leverage
associated with the 59.1% decrease in the defense and security robots business
unit revenue in the three months ended June 28, 2014 compared to the three
months ended June 29, 2013.
Gross margin increased $5.7 million, or 5.3%, to $113.8 million (44.8% of
revenue) in the six months ended June 28, 2014 from $108.1 million (45.7% of
revenue) in the six months ended June 29, 2013. Gross margin as a percentage of
revenue in the home robots and defense and security business units decreased 0.5
percentage points and 10.6 percentage points, respectively. The 0.5 percentage
point decrease in the home robots business unit resulted from incremental
warranty reserves of $2.7 million, driven primarily by actual warranty
experience in certain European markets. In addition, increases in the higher
margin Roomba 800 series robot were offset by a higher mix of lower margin wet
floor care products, as well as increases in other costs of sales during the six
month period ended June 28, 2014 compared to the six month period ended June 29,
2013. We also recorded a smaller favorable adjustment to our returns reserve
during the six month period ended June 28, 2014 than the favorable adjustment
recorded to our returns reserve during the six month period ended June 29, 2013.
The 10.6 percentage point decrease in the defense and security business unit is
attributable to the unfavorable overhead leverage

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associated with the 54.6% decrease in the defense and security robots business
unit revenue in the six months ended June 28, 2014 compared to the six months
ended June 29, 2013.
Research and Development

Research and development expenses increased $1.2 million, or 7.8%, to $17.2
million (12.3% of revenue) in the three months ended June 28, 2014 from $16.0
million (12.3% of revenue) in the three months ended June 29, 2013. This
increase is primarily attributable to increases in consultant costs, occupancy
costs, recruiting fees and legal expenses.
Research and development expenses increased $3.8 million, or 12.4%, to $34.2
million (13.5% of revenue) in the six months ended June 28, 2014 from $30.4
million (12.9% of revenue) in the six months ended June 29, 2013. This increase
is primarily attributable to increases in consultant and contractor costs of
$1.9 million. The remaining increase relates to increases in people-related
costs and occupancy expenses.

Selling and marketing expenses increased by $1.2 million, or 5.5%, to $23.5
million (16.8% of revenue) in the three months ended June 28, 2014 from $22.3
million (17.1% of revenue) in the three months ended June 29, 2013. This
increase is primarily attributable to increases in people-related costs of $0.8
million during the three months ended June 28, 2014 as compared to the three
months ended June 29, 2013. The remaining increase resulted from increases in
customer support costs and third party commissions for the three months ended
June 28, 2014 as compared to the three months ended June 29, 2013.
Selling and marketing expenses increased by $5.1 million, or 15.3%, to $38.1
million (15.0% of revenue) in the six months ended June 28, 2014 from $33.0
million (14.0% of revenue) in the six months ended June 29, 2013. This increase
is primarily attributable to $3.1 million in marketing displays, on-line media
and other selling and marketing costs incurred to support the retail launch of
the Roomba 800 series and Scooba 450 robots, as well as increases in
people-related costs of $2.0 million driven by increased headcount during the
six months ended June 28, 2014 as compared to the six months ended June 29,
2013.
General and Administrative

General and administrative expenses decreased by $3.7 million, or 24.2%, to
$11.7 million (8.3% of revenue) in the three months ended June 28, 2014 from
$15.4 million (11.8% of revenue) in the three months ended June 29, 2013. This
decrease is primarily attributable to decreased compensation and benefit costs
of $2.1 million in the three months ended June 28, 2014

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compared to the three months ended June 29, 2013, as well as a $1.8 million
intangible asset impairment recorded in the three months ended June 29, 2013,
partially offset by increases in other general and administrative costs.
General and administrative expenses decreased by $3.9 million, or 14.1%, to
$23.9 million (9.4% of revenue) in the six months ended June 28, 2014 from $27.9
million (11.8% of revenue) in the six months ended June 29, 2013. This decrease
is primarily attributable to decreased compensation and benefit costs of $2.5
. . .